Breaking Up Big Banks

Coming out of the 2008 recession and the reactionary Occupy Movement, the regulation of Wall Street and big banks has become a top priority for many left-leaning voters. While Democratic candidates generally favor regulation of the financial sector to a greater degree than their Republican counterparts, leading Democrats are divided on how extensively to regulate banks.
Democrats, including current frontrunner Hillary Clinton, have historically relied on Wall Street for a great degree of financial support. Across her career, Clinton’s four main campaign donors have been financial firms, including Citigroup, Goldman Sachs and JPMorgan Chase [1]. In addition, as president, her husband Bill Clinton signed legislation repealing the Depression-era Glass-Steagall Act, which forced the separation of commercial and investment banking, a move now reviled by more left wing Democrats.
This has hurt Hillary Clinton’s standing among Democratic primary voters, and has fueled criticism from her opponents, Vermont Senator Bernie Sanders and former Maryland Governor Martin O’Malley. Unlike Clinton, both Sanders and O’Malley Support the resurrection of the Glass-Steagall Act [2]. Sanders has made these differences central to his campaign, contrasting his longstanding opposition to Wall Street and eschewing of large campaign donations with Clinton’s close ties to banking [3].
This said, all three Democratic candidates support increased regulation of the financial sector and strengthening of the provisions of the post-recession Dodd-Frank Act. The only major difference of opinion between Clinton and her two rivals is over Glass-Steagall [4]. Notably, however, Clinton has released a more detailed plan for banking regulation than has Sanders. Her plan focuses less on challenging the political and economic clout of big banks and more on increasing the authority of federal regulators to check the banks’ excesses [5]. Clinton would give regulators more power to break up banks that carry too much risk for the economy and would place greater scrutiny on the so-called “shadow banking sector” [6]. Both Clinton and Sanders have called for financial-transaction taxes and different measures capping CEO pay [7].
Despite the broad agreement of Democratic candidates on financial regulation, this issue will be an ongoing source of division among primary voters. While Sanders and Clinton’s proposals do not differ greatly, Sanders, in large part due to his voting record and campaign funding, is more broadly trusted by Democrats to be tough on big banks, and the issue will likely continue to play to his advantage.

AGAINST

One of the most common talking points from Senator Bernie Sanders is his plan to break up big banks, recently outlined in his “Too Big to Fail, Too Big to Exist Act” [11], which he submitted for Congressional consideration on May 6th [12]. Presidential candidates Martin O’Malley and Hillary Clinton released similar plans on July 6th [13] and October 8th [14], respectively. Sanders argues that these institutions pose a huge risk to national and world economic stability and harm the middle and lower classes [15]. However, defenders of the free market argue that breaking up big banks would increase banking costs for consumers and destabilize the U.S. economy.

"A 2009 study claimed that banks with assets over $1 billion saw consistent economies of scale, and recent literature has revealed that economies of scale are realized throughout the banking industry, regardless of size."

Proponents of large banks point to scale economies as justification for keeping banks together. A scale economy is a microeconomic phenomenon where a firm can increase output of a product without incurring a proportional cost. For example, telecommunications companies benefit from economies of scale because they have already established the costly infrastructure needed to reach more clients. A 2009 study claimed that banks with assets over $1 billion saw consistent economies of scale, and recent literature has revealed that economies of scale are realized throughout the banking industry, regardless of size [16].

Furthermore, big banks aren’t inherently unstable and in fact contribute to stability. Although large government bailouts drew the most attention in 2008, the government also subsidized over 900 smaller banks through the Troubled Asset Relief Program [17]. Even in large bank bailouts, the biggest banks such as Bank of America and Citigroup both used their assets to help absorb the losses of their competitors [18]. In this way, the two large banks saved the American economy from falling even further down. Because all financial institutions are interconnected, every institution is incentivized to protect the security of the other.

The last problem with any plan to break up large banks is logistical [19]. Senator Sanders’ bill calls for the Secretary of the Treasury to “break up entities included on the Too Big To Fail List,” but provides no direction on how such a large-scale separation should occur. Senator Sanders’ section about breaking up institutions totals under 100 words. With the biggest banks eight to ten times larger than they were in 2008, breaking up these giants seems implausible, if not impossible.

In the end, while it may be cathartic to crucify big banks on the cross of Progressive regulation, doing so will ultimately lead to a weaker economic system. Big banks take advantage of scale economies to reduce costs for consumers and contribute to overall economic stability.

Zach Wong

FOR

Recently, mainstream Democrats have come to accept a view that the federal government has the responsibility to break up so-called “big banks”. This issue, however, is incredibly complex and involves at least two different ways of “breaking up” such banks. There is the call to reinstate Glass-Steagall, which would force any bank that currently has a commercial banking and investment banking arm to separate those two entities, and then there is breaking up too-big-to-fail banks, which means breaking up banks that are so big that they pose a systemic risk to the entire economy.

"What this means is that main street Americans who just use banks as a day-to-day necessity can lose everything due to the speculation of of the wealthiest members of society."

First, there is a logical argument in favor of the reinstatement of the Glass-Steagall act. Investment banks often deal in speculative matters, buying and selling complex derivatives in order to help the wealthiest capital owners become wealthier. The clients of investment banks, by nature, have to be able to absorb financial loss from speculative decision-making. They are labeled by the federal government, more specifically the Securities and Exchange Committee, as “accredited investors”, meaning they have the ability to take more risk with their assets. Investment banks have often combined with commercial banks, the banks you and I take money out of every day or the banks where we would get a mortgage if we wanted to buy a house, to streamline the packaging of certain derivatives called mortgage-backed securities. These allow wealthy individuals to speculate on whether or not a typical American will be able to pay back his or her mortgage. Due to this marriage of commercial and investment banking, if the investment bank starts experiencing losses, it no longer affects just the accredited investors that are its clientele, but also means that the commercial banking arm experiences losses as well. What this means is that main street Americans who just use banks as a day-to-day necessity can lose everything due to the speculation of of the wealthiest members of society. While this logically and morally does not make sense, the argument has empirical evidence to prove its case as well. The merging of commercial and investment banking as a result of the repeal of Glass-Steagall in the 90’s is said to have majorly contributed to the financial crisis of 2008 [8]. This is because it helped create the housing bubble, by streamlining the packaging of mortgages into mortgage backed securities as both those services were now under one roof.

The second type of “breaking up” differs from the first, in that it deals only with the idea of financial institutions that present a systemic risk to the broader economy [9]. What this means is that there are some banks that are so big and so important to our economy that they cannot fail or else there would be economic catastrophe. These institutions know that this is the case and that the federal government will come to their aid if they ever reach financial straights. This has led to serious moral hazard on the part of these large institutions as they know they can speculate as much as they want without repercussion because the federal government will support them if they fail [10]. Thus, in order to prevent such organizations from taking advantage of the typical American taxpayer, we must break up any institution that is “too big to fail”–in other words, too big to exist. This would add more security to our economy and it would ensure that Main Street will never have to bail out Wall Street speculators again.

Chris Raguz

REBUTTAL - AGAINST

The first argument Mr. Wong makes is that banks need size in order to increase efficiency, essentially arguing that banks experience a scale economy. While this might be true for banks over $1 billion dollars as Mr. Wong states, this is highly disingenuous. According to a study conducted by Colorado College of 1,200 banking institutions, there is actually a diseconomy of scale as banks get larger. What this means is that the current big banks, worth upwards of $200 billion dollars and dealing with assets in the trillions of dollars, are not experiencing any increased efficiency operating at this enormous size.

While Mr. Wong argues that banks have an interest in protecting each other from collapse, he fails to see the problem at hand. Big banks continually fall into trouble and it takes taxpayer money to bail out the systemic harm caused by just one of these banks collapsing, such as Lehman brothers and Bear Sterns in 2008. Where was the financial industry then? I’ll tell you where: taking huge sums of taxpayer dollars to pay their CEOs some of the largest bonuses ever experienced by Wall Street. Even if they bail each other out, the value of main streets assets should not have to continually face massive business cycles because of the greed of large institutions that have no business operating with this much risk involved.

Lastly, Mr. Wong claims it is too difficult to break up big banks. Even if he is right, does this mean we should not do it? If the fate of our economy is at stake here, why would we not make the hard decision. If we made every decision based on the difficulty of action, where would we be as a nation? The interesting part is this is not as difficult as my opponent speculates. Big banks are not monolithic entities; they are simply a collection of different services. Banks often spin off divisions all the time. This would simply be a mandatory spin-off of some operations that can easily exist separate from the rest. For example, the investment banking operations could be split into a company for equity underwriting, a company for debt capital markets, and a company for mergers and acquisitions. Big banks are just conglomerates of other banking activities. Breaking them up is even easier than putting them together.

REBUTTAL - FOR

Mr. Raguz argues that Glass-Steagall should be reinstated because it will protect depositors at commercial banks from losing their money if the associated investment bank fails. Indeed, if this were the case, I would be the first person to call for reinstatement. However, such an argument overlooks the broad securities already in place for depositors. This security comes from the Federal Deposit Insurance Corporation (FDIC), a government agency established by the Banking Act of 1933. This Act is also known as Glass-Steagall [20]. The FDIC insures up to 250,000 dollars for every depositor in every approved bank in the United States. Since its inception in 1933, no investor has lost a single penny from an insured account due to a bank failure [21]. The argument that Glass-Steagall is needed to protect depositors is without merit and needlessly propagates fear.

Mr. Raguz’s second argument is stronger. Moral hazard is a significant problem facing the banking and regulation industries and was exacerbated by the 2008 crisis. However, breaking up big banks is not the best way to solve this issue. Synthetically fracturing banks could have far-reaching economic consequences. Big banks rely on scale economies to increase efficiency, improve returns, and decrease costs for customers. Government interference in this field could destroy these advantages and have long-term effects on the U.S. economy.